School of Real Estate & Planning
Private Equity:
Its Role in Takeovers and Mergers
MSc REMCPM, Wuppertal
September 2008
18 September 2008
© Colin Lizieri 2008
www.henley.reading.ac.uk
Agenda
1. Private Equity
2. Private Real Estate Funds
3. Mergers and Acquisitions
4. Taking a Firm Private
5. Taking a Real Estate Firm Private
Colin Lizieri, September 2008
2
Private Equity
• Equity Capital / Wealth Seeking Investment
Opportunities
• Pooling of Individual Wealth into Funds
• Private Management of that Wealth
• Private Implies:
– Not Listed on Equity Markets
– Less Subject to Regulatory Control and Scrutiny
• Private Equity Does Not Imply:
– Capital invested is solely equity: most funds are geared
Colin Lizieri, September 2008
3
Leading Private Equity Firms*
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Carlyle Group
Goldman Sachs Principal Investors
Texas Pacific Group (TPG)
Kohlberg Kravis Roberts (KKR)
CVC Capital Partners
Apollo Management
Bain Capital
Permira
Apax Partners
Blackstone Group
*
This is only one of a number of rankings – there are others with
different memberships and positions. By its nature, private equity is
private so there are no public information sources.
Colin Lizieri, September 2008
4
Private Equity: Basic Structure
Investor
Investor
Investor
Investor
Investor
Investor
Investor
Investor
Investor
Limited Partnership
Private Equity Firm:
General Partner
Lenders
Private Equity Fund
Investment
Colin Lizieri, September 2008
Limited Partnership
Investment
Investment
Investment
5
Private Equity: Main Activities
• Venture Capital
– Provision of equity to new companies, start ups etc.
– Acquire equity stake and seat on board
– Exit – IPO or sale of company / shares
• Growth Capital
– Investment in mature firm seeking to expand
– Acquire equity stake in firm
– Exit – sale of stake after growth achieved
• Buy Outs
– Leveraged buy outs, management buy outs
– Acquire control of firm
– Sell assets or stake in the firm
Colin Lizieri, September 2008
6
Private Equity: Opportunities
• Distressed Situations
– Acquire Assets When Markets in Trouble
– Acquire Assets When Capital Scarcity
– For Example: Real Estate Recovery Funds
• Asset Stripping
–
–
–
–
Identify Firms With Real Assets
Assets Not “Fairly” Priced By Market / Company
For Example: Real Estate Trading at Discount to NAV?
Acquire Firm and Sell Assets for Profit
• Mezzanine Finance
– Conventional Lending May Have Loan to Value Limits
– Lend / Provide Capital Above LTV
– Obtain High Interest Rates and Share in Any Profits
Colin Lizieri, September 2008
7
Some Landmarks
• KKR Acquisition of RJ Nabisco, 1989
– “Barbarians at the Gates”
• Drexel Burnham Lambert
– Junk bonds and insider trading
– Michael Milken, SEC investigations and Chapter 11 1990
• Venture Capital and the Internet Boom
– Seedcorn capital for major IT firms created in the boom years
– Seedcorn capital for many of the IT firms that disappeared too!
• The Buy Out Boom of the mid-2000s
– MGM, Hertz, Toys R Us, Burger King, Alliance Boots
• Equity Office Properties
– Largest US Office REIT
– Taken private by Blackstone for $38billion, 2006
Colin Lizieri, September 2008
8
Sovereign Wealth Funds
• Government Sponsored / State Investment Funds
• Major Players in Investment Markets
– e.g. Abu Dhabi Investment Authority ~$850bn
– e.g. Norway – Government Pension Fund (Global) ~$380billion
• Just decided to invest up to 10% in real estate ..
– e.g. Singapore – GIC ~$330bn
– E.g. China Investment Corporation ~$200billion
• Predominantly Equity Investors
• Ability to Invest in “Difficult Conditions”?
• Often Invest in Private Equity Funds …
Colin Lizieri, September 2008
9
Private Real Estate Equity
• Parallel Development to 2000s Private Equity Boom
• Real Estate Funds:
–
–
–
–
Establish tax efficient structure
Pool equity from different investors
Add debt at agreed level
Acquire real estate assets
• Benefits / Costs for Investors
–
–
–
–
Can diversify at lower cost, build global portfolios
Access specialist management and specialist asset types
Lack of management control, high fees, poor transparency
Illiquidity, particularly in bad markets
Colin Lizieri, September 2008
10
Growth of European Private RE Funds
350
1000
900
300
GAV €bn
Number
800
250
700
600
200
500
150
400
300
100
200
50
100
20
08
20
06
20
04
20
02
20
00
19
98
19
96
19
94
19
92
19
90
19
88
19
86
19
84
0
19
82
19
80
0
Source: Property Funds Research
Colin Lizieri, September 2008
11
Fund Styles
Opportunistic
Value -Added
Return
Repositioning, redevelopment, releasing
re --leasing
Distressed sellers, speculative
development,
development,
financial
engineering,
emerging
sectors
financial engineering, new markets
Core Plus
Stable lease
roll, more
active management
Stable
lease roll,
moderate
NOI
upside
income enhancement strategies
Return:20%+
Return:18%+
Leverage:70%+
Return: 15-18%
16-19%
Leverage: 60-65%
Core
Core
Fully leased
-tenant
property
Fully
leasedmulti
prime
property
Return:10-14%
Return:11-14%
Leverage:30-50%
Leverage:40-60%
Return: 6 -10%
Return:8-10%
Leverage:0-30%
Leverage:0-50%
Risk
Colin Lizieri, September 2008
12
Private Real Estate Funds and REITs
• REITs Have Liquidity But High Volatility
• REITs May Trade at Discount to NAV
– Because NAV is wrong?
– Because market sentiment is bad??
• Private Real Estate Vehicles May Acquire REITs
– Benefit from NAV discount or improve management
– Asset strip or run efficiently
– Exit by Taking REIT back public?
• Private Real Estate Funds May Go Public
– Market conditions favourable
– Exit strategy for private investors
Colin Lizieri, September 2008
13
Mergers and Acquisitions
• Reasons for Taking Over a Company:
–
–
–
–
–
Superior management efficiency
Undervalued company (private information)
Synergy (economies of scale, marketing etc)
Market power / market share
Diversification??
• Benefits the bondholders and managers, but not shareholders
– Higher earnings per share??
• Higher eps probably comes from lower growth prospects
– Vertical integration?
• Are transaction and management costs lowered by integration?
Colin Lizieri, September 2008
14
Merger Waves
Source: Andrade et al. Journal of Economic Perspectives, 2001
Colin Lizieri, September 2008
15
Reasons for Merger Waves
• Often Merger Waves Relate to Particular Industries
– 1970s: Mining, Oil & Gas, Real Estate, Clothing
– 1980s: Textiles, Food, Manufacturing, Finance
– 1990s: Media, Telecoms, Real Estate, Hotels
• Changes in Regulation
– For example deregulation of global finance 1980s
– For example deregulation of telecom industry 1990s
• Technology Shocks and Structural Change
– Media and telecoms
– Global sourcing of food and clothing
• Economic Environment
– 2007-8 Credit Crunch!!
Colin Lizieri, September 2008
16
Economic Impact of M&A
• Generally share performance of acquiring firm suffers
– Have to pay control premium to acquire firm
– The “Winner’s Curse” in competitive bidding
– Often acquisition involves taking on debt
• Generally, target shareholders benefit
–
–
–
–
Capture the control premium
Wealth transfers from bidder to target shareholders
Target firms under-perform in period prior to bid
But bidders may over-estimate ability to improve situation
Colin Lizieri, September 2008
17
Taking a Firm Private
• Acquire Controlling Interest in Shares of Firm
• Delist the firm (withdraw from equity market)
• Reasons:
– Information and transparency: firms that lack public
information and scrutiny more likely to be mispriced
allowing informed trading
– Liquidity: firms that do not offer equity market liquidity
more likely to be taken private
– Control: private firms have more tight control, less
diversified shareholding
– Access and Cost of Capital: if costs of public capital too
high or firm has no capital constraints, more likely to go
private
Colin Lizieri, September 2008
18
Buying Out a Property Company
•
The Basic Idea
– Property company owns €600million real estate assets
– Firm has cash and other assets of €20 million
– Book value of firm’s debt is €280million
– Company has 8million shares in issuance
– Current share price is €38
•
Strategy
1. Buy the firm: 8m * €38 = -€304million
2. Sell all the real estate: +€600million
3. Repay all the debt: -€280million
4. Walk away with profits and cash:
-304 +600 -280 +20 = €36million
Crude accounting profit 36/304 = 11.8% <= Wrong! Bad!!
Colin Lizieri, September 2008
19
Buying Out a Property Company
Refining the Model …
• Think About Timing and Uncertainty
– How Long Does It Take To Sell the Real Estate?
– What Will the Achieved Sales Values Be?
– Time Value of Money – Must Use a DCF Approach
• Think Properly About Costs (and Income)
– How Much Will You Really Have To Pay For the Firm?
– Are There Repayment Penalties For The Loans?
– Must You Repay Loans Before You Can Sell the Real Estate?
– What About the Transaction Costs for the Real Estate?
– What About Tax? Are There Capital Gains To Be Paid?
– Don’t Forget the Rental Income (and Property Costs)
• Think About Finance
– Is This a Leveraged Buy Out? Costs, Interest Payments etc.
Colin Lizieri, September 2008
20
Project Cashflow – Simplified Template
Acquisiton Price
Loan O/S
Debt O/S
Prop Value
Sale of Property
Time 0
304.00
200.00
280.00
600.00
Equity
Rental Income (6% p.a.)
Prop Costs (2.0% p.a.)
Loan Int (6%)
Debt Interest (7%)
Fees on sales etc.
Repayment penalty (1%)
Cash in hand
Profit from Sales
CASHFLOW
-104.00
Project IRR =>
10.02%
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
200.00
230.00
550.00
50.00
200.00
130.00
450.00
100.00
200.00
30.00
350.00
100.00
80.00
0.00
200.00
150.00
0.00
0.00
50.00
150.00
0.00
0.00
25.00
25.00
0.00
0.00
5.00
20.00
0.00
0.00
0.00
5.00
9.00
-3.00
-3.00
-4.90
-1.25
-0.50
8.25
-2.75
-3.00
-4.03
-2.50
-1.00
6.75
-2.25
-3.00
-2.28
-2.50
-1.00
5.25
-1.75
-3.00
-0.53
-3.75
-1.50
3.00
-1.00
-1.20
0.00
-3.75
-0.80
0.75
-0.25
0.00
0.00
-0.63
0.00
0.38
-0.13
0.00
0.00
-0.50
0.00
0.08
-0.03
0.00
0.00
-0.13
0.00
0.00
-3.65
0.00
-5.03
0.00
-4.28
0.00
-5.28
70.00
66.25
25.00
24.88
20.00
19.75
5.00
4.93
20.00
-84.00
No Tax Adjustment … Many Simplifying Assumptions …
Colin Lizieri, September 2008
21
Summing Up
• Private equity important part of economic landscape
• Private equity can promote market efficiency:
– By identifying mispriced firms
– By eliminating inefficient managers
• Mergers and acquisitions may promote efficiency
– Must be a sound economic or organisational basis for any
increase in value
• Real estate, M&A and private equity
– Potential mispricing of property companies?
– Potential for information and management inefficiencies?
• Assessing Deals
– Must consider full cashflow implications of any deal
– What is the source of added value? Are there costs?
Colin Lizieri, September 2008
22